By Peter Apps
LONDON, Jan 22 (Reuters) - With developing economies savaged by the global economic downturn, emerging market investors are looking back to where the crisis began to show the first signs of recovery.
Emerging markets might have seen booming domestic demand and been trading more with each other than ever before, but with developed demand -- particularly U.S. demand -- taken out of the equation, growth is braking sharply and unemployment rising.
No-one uses the word "decoupled" seriously any more.
"This is a global recession," said Clare Dissaux, strategist at Millennium Global. "You are not going to get any sustained recovery in emerging markets until you see stabilisation in the US credit and housing markets. This is likely what it takes to trigger some rebound in risk appetite on a broad basis."
The benchmark emerging equities index suffered even worse than its developed counterpart, plunging 55 percent in 2008 and losing 8.5 percent since the beginning of January. Emerging debt and currency also tanked as investors sought refuge in perceived safe haven dollars and treasuries.
With U.S. unemployment soaring and banks still reluctant to lend, there is little sign of recovery in the United States. Goldman Sachs warned this month a chronic oversupply of housing meant prices might have much further to fall.
The benchmark Standard & Poor's/Case-Shiller home price index showed house prices across 20 metropolitan areas down a record 18 percent in October -- the most recent month surveyed -- against a year earlier.
Nevertheless, just as every bubble must burst, no price crash can continue for ever, and at some stage US houses will be cheap enough for enough buyers who still have jobs, capital or access to loans to buy in enough quantity that prices begin to recover.
That should help stimulate broader economic activity, boosting both domestic American growth and demand for imports -- hopefully reversing a trend that has thrown 10 million Chinese migrant workers out of jobs in recent months and boosted worldwide unemployment and social misery.
Inevitably, economic recovery in emerging markets will lag behind the United States -- but possibly not by much.
MARKETS CHEAPER
The European bank for Reconstruction and Development (EBRD) said last week it expected emerging Europe -- seen as one of the most exposed areas to the crisis -- would lag both the U.S. and Europe in its recovery but only with a six month delay.
Most expect Asia to recover first, followed by Latin America, Europe, the Middle East and Africa.
But predicting the beginning of the turnaround is far tougher. Most predictions put it sometime around the middle of the year, but with most official forecasts cut time and again in recent months few would count on it.
Investors hope stimulus packages from U.S. President Barack Obama will bring the rebound closer -- but remain cautious.
Markets, both developed and emerging, will try to predict the upturn in advance but many investors will be holding out for solid data to prove the worst is over before jumping back in.
Most investors are simply sniffing around the edges of currently illiquid emerging markets, adjusting portfolios rather than taking large new positions -- although some are willing to be more enthusiastic and jumping in to snap up cheap assets.
Asian markets tend to top investor picks lists.
"Company valuations are compelling," Hugo Young, managing director of Aberdeen Asset Management Asia, said in a note. "Of course, they may get cheaper still given the uncertainty surrounding the global economy but... now is without doubt one of the most attractive times to invest in Asia Pacific equities that I have witnessed in 25 years."
Chinese stock markets in particular had already lost heavily before the global market crash in September as a speculative boom ran out of steam. Now the Shanghai index is one of the few to show gains so far in 2009, up 10 percent despite grim economic data.
DIFFERENT NEXT TIME?
Growth in the fourth quarter slowed to 6.8 percent year on year from 13 percent in all of 2007 -- below the 8 percent growth seen necessary to create enough jobs for migrant workers and graduates and avoid potential unrest.
But investors still take heart from China's near $2 trillion reserves and its plans for a $585 billion stimulus package to preserve growth even if Western markets remain weak.
"In China, the factories will continue to close... but the construction industry should be supported by the government stimulus package," said Millennium's Dissaux.
Millennium manages some $13 billion but does not provide a breakdown of how much is in emerging markets.
India, with a much lower proportion of GDP made up from exports, was less exposed to the downturn but will also benefit less from the eventual recovery, she said. The sheer volatility of oil prices made predicting Russian assets almost impossible.
But while the United States may provide the turning point, in the longer run most analysts see emerging markets taking up a greater and greater part of the global economy.
Even in the shorter term, once a global recovery begins many see attention turning to the U.S. current account deficit and its colossally indebted balance sheet, sending the dollar lower and thereby benefiting emerging markets.
And some believe the next time around, the whole dynamic of the global economy will have shifted.
"The U.S. consumer we do not believe can be the growth engine for global growth going forward," said Gary Baker, head of the Europe, Middle East and Africa strategy group at Bank of America Securities-Merrill Lynch. "I expect eventually the emerging markets to be the real engine for global growth going forward and arguably that's where I think along global investors are going to be grouped." (additional reporting by Kylie MacLellan; Editing by Andy Bruce)